Direct line: 020 7066 1280
Email: andrew.bailey@fca .orq.uk
Rt Hon Andrew Tyrie MP
Chairman of the Treasury Committee
House of Commons
London SWlH 9NB
Financial Conduct Authority
Quayside House
127 Founta1nbndge
Edinburgh
EH3 9QG
Tel +44 (0) 131 301 2000
Fax. +44 (0) 131 557 6756
www.fcaorg.uk
13 January 2017
During my appearance at the Committee on 8 November 2016 you requested a written
response on two issues. First, some information on what value of UK financial services could
be lost if access to t he European Union (EU) market were available only on the basis of global
standards, and second, some further detail on transitional arrangements which might be
established fo llowing the UK's withdrawal from the EU.
I am also aware t hat on 12 December 2016 the Treasury Committee issued a call for evidence
on transitional arrangements. This letter answers the questions contained within the call for
evidence where we believe it appropriate for the FCA to comment. We do not answer questions
where others - such as firms - are better placed to respond, for example with regard to pre­
emptive actions that may be taken by the private sector.
Current Global Financial Regulatory Standards
There are a number of global standard -setting bodies in the area of financial services. The EU
often seeks to implement such standards via legislation that applies across the single market.
The scope and membership of standard setters varies, but they include regulatory authorities
of G20 jurisdictions, and sometimes many others, who work together with the aim of both
developing and implementing regulatory standards and principles. The standards themselves
are not legally binding in the way that a treaty is legally binding under public international law.
Rather they provide a broad, common framework across specific global markets. For example,
the FCA is a member of the International Organization of Securities Commissions {IOSCO).
This is the international body that develops, implements and promotes adherence to robust
global standards in securities regulation, with the objectives of protecting investors, ensuring
that markets are fair, efficient and transparent, and reducing systemic risk . IOSCO itself works
closely with the Financial Stability Board (FSB) on regulatory reform. Here G20 commitments
provide an additional impetus to member jurisdictions to implement agreements. The FCA is
directly represented at the FSB, and other bod ies including the International Association of
Insurance Supervisors.
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In terms of the relationship with EU legislation, certain initiatives following the financial crisis
have been informed by global standards and follow the broad direction of travel set by global
bodies. However, the legislation that provides the specific legal underpinning for integrated EU
financial services markets has become much more granular, technical and detailed in its
provisions. It would however be possible to take a different approach and to base market
access on higher level standards which are transparent and subject to regular review. I will
expand on this in the section that follows.
The table below shows - briefly - the main pieces of EU financial services legislation that are
linked to a greater or lesser extent to principles set by global bodies, or in some cases
influenced by those principles.
EU legislation
Global standards or principles linked to or
influencing legislation
Markets in Financial Instruments
Directive (MiFID II)
G20 commitment for trading of standardised over­
the-counter (OTC)_ derivatives on exchanges or
electronic trading platforms where appropriate;
IOSCO Principles for regulation; IOSCO Principles for
the regulation and supervision of commodity
derivatives; IOSCO Principles for Direct Electronic
Access to markets
Market Abuse Regulation (MAR)
IOSCO Principles for the regulation and supervision
of commodity derivatives
G20 commitments for trade reporting of all OTC
derivatives to trade repositories, central clearing of
standardised OTC derivatives through central
counterparties and margining of non-centrally
cleared derivatives; Committee on Payments and
Market Infrastructures (CPMI)/IOSCO Principles for
Financial Market Infrastructures; Basel Committee
on Banking Supervision (BCBS)/IOSCO margin
requirements for non-centrally cleared derivatives
European Market Infrastructure
Regulation (EMIR)
Central Securities Depositories
Reaulation (CSDR)
Proposed Securitisation
Regulation
CPMI/IOSCO Principles for Financial Market
Infrastructures
BCBS-IOSCO criteria for simple, transparent and
comparable securitisations
Prospectus Directive
IOSCO International disclosure standards for crossborder and initial listings by foreign issuers
Regulation of Money Market
Funds (MMF)
IOSCO Policy Recommendations for Money Market
Funds
Credit Rating Agencies (CRA)
Regulation and Directive
G20, FSB and IOSCO Strengthening CRA governance
and reliance on ratings
Benchmarks Regulation
IOSCO Principles for financial benchmarks
Capital Requirements Regulation
and Directive (CRD4)
The BCBS's Basel III accord. However the scope is
for 'internationally active banks' at the global level.
In the EU this is extended to capture all deposit
takers and investment firms, including those
investment firms prudentially regulated by the FCA.
Third and fourth anti-money
laundering directives (3MLD and
4MLD) and the Wire Transfer
Regulation (WTR).
Financial Action Task Force (FATF)
Recommendations - International anti-money
laundering and combatting financing of terrorism
and proliferation
International Accounting
Standards Regulation
International Accounting Standards Board (IASB). 1
The Role of Global Standards
A primary aim of global standards is to promote regulatory outcomes that are consistent
across jurisdictions, thereby avoiding so-called 'regulatory arbitrage' - the risk that firms
might seek to locate their business in a jurisdiction where the regulatory regime is perceived to
be less onerous. They also seek to ensure minimum standards to enhance financial stability
and provide for a framework for cooperation among supervisors. 2
By helping to promote international consistency and hence reducing the risks of regulatory
arbitrage, global standards can support trade in financial services between jurisdictions.
However, global standards, as currently conceived, are not designed per se to be a tool to
facilitate market access, unlike trade agreements. Therefore they are not currently regarded as
providing an alternative either to the financial services passport within the EU single market or
to third country access provisions as provided in certain EU directives such as MiFID II. I
des.cribed these mechanisms in my previous letter to you of 28 October 2016.
Standards developed by global bodies are the product of consensus-building across a range of
diverse members. Such standards have to be designed to apply across a broad range of legal
and regulatory regimes and therefore they have tended to be high level in nature. We believe
that more work could be done to promote effective standards in areas of capital markets and
conduct of business policy at the international level.
A more comprehensive body of global standards, which could provide a regulatory basis to
facilitate market access, is conceivable could be beneficial in promoting open trade in financial
services. This is an aspirational goal, the realisation of which would require a strong degree of
international consensus and cooperation.
I
Note that the United States adopts its own accounting standard.
See for example paragraph 34 of the Basel III Capital Accords on the level playing field point, IOSCO objectives of
"building sound global capital markets and a robust global regulatory framework", or the FSB Charter.
2
Absent a cha nge of approach, it would not provide a solution to the shorter-term challenges
around the UK's w ithdrawal from the EU . Global prudential standards established via the Basel
Committee, for example, have enjoyed a strong degree of support and consistent
implementation. Other examples are discussed in the table above. There is no reason prima
facie to assume that a similarly comprehensive set of standards could not be established in
other areas of financial regulation if there is a collective desi re to do so.
In terms of how more effective global regulatory standards might be beneficial, it may be
helpful to provide an example. Currently, where a firm seeks to enter an overseas market to
undertake regulated financial services activity, it will likely be requ ired to attain authorisation
from the relevant regulatory authority in that market. The information that the firm is obliged
to give to the regulator as part of its application varies from jurisdiction to jurisdiction. One
important piece of evidence that the regulator may consider is whether, and to what extent,
the firm 's domestic authorities adhere rigorously to global financial regulatory standards. This
may help facilitate the firm's authorisation application. Under the UK's authorisation reg ime,
for example, where a third country firm is making an application the Financial Services and
Markets Act (FSMA) allows the FCA and/or PRA to have regard to the supervision of that firm 's
overseas regulator in taking account of the regulator's opinion . Currently, while being subject
to a jurisdiction which adheres to globa l standards may be a factor influencing authorisation, it
is highly unlikely to be a sufficient condition .
If the body of global standards were to become more comprehensive, it might provide a
broader basis on which authorisation decisions could be made. This would of course need to be
supported by consideration of how such standards would be implemented and then supervised .
This could help to make the authorisation process more efficient, potentially reducing barriers
to entry and promoting a more competitive market. At the extreme, a system of mutual
recognition could be established. Bilateral mutual recognition between securities regulators has
some precedents but is far from commonplace. For example, the United States Securities and
Exchange Commission (SEC) and the Australian Securities and Investments Commission
(ASIC) signed a mutual recognition agreement in 2008 which provides a framework for US and
eligible Australian stock exchanges and broker-dealers to operate in both jurisdictions, without
- under certain circumstances - the need for separate regulation in each country. 3 To be clear,
however, such a scenario could only be realised where regulators had sufficient assurance in
the effectiveness of each other's regimes .
Finally, we do not have a measu re of the value of financial services that may be impacted in
the event that passporting arrangements were no longer applicable to UK financial firms alter
the UK's withdrawal from the EU . However, to draw on the content of my previous letter to the
Committee of 28 October 2016, I reiterate that global standards and trade agreements do not,
at least currently, provide for the recognition of authorisations in the way that the single
market directives do.
·
3
For more information please see http://asic.gov.au/about-asic/media-centrc/find-a-media-release/2008-releases/08­
193-sec-australian-authorities-sign-mutual-recognition-agreement/
Transitional arrangements
This leads me on to your second question in relation to possible transitional (or more
accurately "implementation") arrangements following the UK's withdrawal from the EU. As you
are aware, any agreement on the framework for the future relationship between the UK and
EU following withdrawal is a matter for the Government and Parliament, on the one hand, and
the EU institutions, on the other, in accordance with Article 50 of the Treaty on European
Union. The Committee asks in its call for evidence whether transitional arrangements are
compatible with the Government's intention to leave the EU. I believe that they are indeed
compatible with leaving the EU, and, furthermore, would likely help to support a smooth
withdrawal process.
Our statutory objectives require us to seek to mitigate risks to consumer protection, market
integrity and competition in the interests of consumers. We therefore view the risks around UK
withdrawal from the EU in the context of those objectives. Hence, we believe a smooth
transition will be important to avoid material risks to each of those objectives from arising by
providing for an implementation period. My teams are working carefully to assess the
likelihood and impact of such risks arising and possible measures to mitigate them. This work
is continuing; however I can offer some preliminary thoughts. As you would expect, the FCA
will continue to work closely with the Government throughout this period.
Transitional Arrangements in Financial Regulation or Free Trade Agreements
Given the variety of possible meanings that could be attached to the phrase transitional
arrangements, it may be helpful to start by providing some context, considering their use in
other international agreements.
The function and purpose of transitional arrangements varies depending on the particular
situation in which they are used; generally within a financial services regulation context they
provide a bridging period of time between agreement on any new rules and their required
implementation by market participants. They are put in place in order to help mitigate
execution and operational risks attached to a substantive change in the regulatory framework.
They give market participants a clear view of their future rights and obligations and allow a set
period of time to prepare for a smooth transition by, for example, making changes to internal
processes, IT systems and staffing where necessary. Taking IT system changes as an example,
we encourage firms to devote sufficient time and resources to building robust IT systems, and
there can be significant risks associated with implementing changes too fast, including for
consumers.
In general, in the context of EU financial services regulation, transitional provisions are often
written into individual, specific pieces of legislation and serve to provide exactly this type of
bridging period. The transitional arrangements are agreed at the end of the process of making
the legislation, in order that the constituent elements of the new rules are understood and a
judgement can be made about the length of time required to prepare for the implementation
of the rules. The length of the period depends on the significance of the changes. During this
time firms may not need to comply with all the new rules as set out in the legislation (though
some may apply immediately), but they should prepare for their implementation. Sometimes
transitional provisions provide a glide path of gradually increasing requirements, for example
the increased capital requirements under CRDIV.
Within EU financial services legislation this time period ranges from six months to eight years.
However, some time periods have been significantly longer, notably Solvency II which includes
certain provisions allowing firms up to 10 years to adapt to the composition of capital
requirements set out in the Directive, and up to 16 years to transition to a market consistent
regime on the valuation of technical provisions.
There are other types of transitional arrangements ·beyond those in EU legislation. For
example, in the domestic regulatory framework, the Financial Services (Banking Reform) Act
2013 set out requirements for structural reform of the UK's banking sector. Firms are required
to implement the reforms by 1 January 2019. The six year period between the finalisation of
the Act and the implementation deadline is to allow for the complex restructuring of legal
entities required by the banks within the scope of the legislation. Looking more broadly than
financial services, and indeed beyond the EU, global trade deals tend also to provide for
transitional arrangements. For example, the recent Association of South East Asian Nations
(ASEAN)-Australia-New Zealand Free Trade Agreement (FTA) was signed in 2009, and was
implemented by all participating countries three years later.
So, whilst transitional arrangements can vary in their nature, they tend all to follow a similar
principle of providing a bridging period to enable those impacted by new rules to implement
the necessary changes, thereby reducing execution risks and, in turn, risks to consumers. The
transitional arrangements themselves are typically established as part of the overall final policy
agreement.
Transitional arrangements in the context of EU withdrawal
The UK's withdrawal from the EU is, of course, different from the implementation of new
legislation or trade agreements. Article 50 foresees a period of two years (subject to possible
changes as described in the text of the Article) for negotiations towards withdrawal
arrangements. Article 50 notes that the negotiations on withdrawal should take account of the
framework of the future relationship between the EU and the UK.
The Government's proposed EU Withdrawal Bill notwithstanding, to the extent that the future
regulatory arrangement for trade in financial services between the EU and UK is not clear by
the end of the two year Article 50 negotiation period, transitional arrangements may be
required to provide a degree of regulatory continuity and certainty until the future framework
is established.
The nature of the transitional arrangements will be determined in part by the degree to which
the future framework is likely to differ from the status quo. Clearly, transitional arrangements
should facilitate, rather than hinder, the eventual establishment of the future framework, if
that is to be the ultimate aim of both parties in the negotiation.
The degree of preparation and change that firms may need to undertake will depend on the
degree to which the regulatory framework following the UK's withdrawal from the EU differs
from the existing arrangements. For example, if certain firms believe it will be necessary for
them to provide products and/or services from a legal entity based within the single market,
the firm is likely to require authorisations from the regulator in the chosen jurisdiction. It may
also need to switch its contractual relationships with certain clients to that legal entity.
The extent to which such considerations apply will vary between different firms, within and
across different sectors.
Risks arising from a 'cliff-edge' exit scenario
There are multiple issues or risks inherent in transitioning out of the UK's existing regime,
which become particularly acute in a 'cliff-edge' scenario, whereby the regulatory framework
for UK financial services changes immediately and substantially on the day of EU withdrawal
and there are no transitional arrangements in place.
From an FCA perspective, the most critical risks relate to market integrity and consumer
protection, but there are also competition risks, and wider legal, operational and general
market stability risks to consider. I provide three examples below. It is worth noting, also,
that to the extent that markets are cross-border, these risks may well affect regulators in
other jurisdictions to a greater or lesser degree.
The first example to consider relates to passporting. The figures cited in my letter to you of 17
August 2016 show that as at July 2016, there are over 8,000 firms passporting into the UK
from other EEA countries under various single market directives. These firms are authorised by
their home state regulator, and, through the passport, are able to do business in or into the
UK by virtue of that authorisation. The single market in financial services essentially relies on
the mutual recognition of authorisations between regulators and mutual confidence in each
other's supervisory oversight based on harmonised rules. Following the UK's withdrawal from
the EU, and if such passporting rights and single market protocols no longer apply, there is a
risk that those firms may continue to do business in the UK - perhaps inadvertently - without
having the appropriate regulatory permissions in place. Similarly, funds domiciled in another
jurisdiction may lose the ability to be marketed to UK investors. Where contracts provide for
the performance of certain services over a period of time, it may not be easy or even possible
to 'cease' business activities without incurring the risk of legal action for failure to deliver on
such obligations. Indeed, if the loss of passporting is only confirmed late in the negotiations,
then we could see a situation in which the FCA has insufficient time to process new
applications for those firms who wish to continue doing regulated business or offering certain
products here and require a UK authorisation to do so. This may carry with it market integrity,
competition and consumer protection concerns.
In this scenario, transitional arrangements may be useful to ensure that existing EEA firms
doing business in or into the UK have the appropriate permissions to continue operating in the
UK. This might mean providing a suitable time period for firms and regulators to process new
authorisation applications. Based on average statistics for the time taken to process new
authorisation applications from July to September 2016, new retail authorisations took on
average 23.1 weeks and new wholesale authorisations took on average 21 weeks. 4 The time
taken generally depends upon the complexity and completeness of the application. Indeed, we
would expect that, in the transition to a new set of arrangements, the necessary time period
could be significantly longer.
4
See https://www.fca.org.uk/publication/corporate/key-perfonnance-indicators-september-2016.pdf
My Jetter of 17 August 2016 also contained figures on UK-authorised, outward passporting
firms that may similarly be affected by a loss of passporting in such a scenario. Just as I have
described above with regard to inward passporting firms, these outward passporting firms may
need to seek an authorisation from an EEA Member State regulator in order to continue doing
branch or services business on a cross-border basis. For example, with regard to payment
services, around half of all payment services firms in the EU operate out of the UK, with
approximately 25% of all non-bank payment service providers authorised in the UK holding
passports to operate cross-border. These firms may need to seek an authorisation from an EEA
Member State regulator prior to the UK's withdrawal from the EU in order to continuing doing
business in EEA jurisdictions. Lead in times of 12-18 months have been quoted as necessary to
achieve this.
Similarly, within the asset management sector, UK asset management firms bring in a
significant portion of their revenue by providing portfolio management services to funds
domiciled outside the UK or segregated mandates for EEA (excluding UK) clients. This business
relies on a combination of passports and delegation arrangements under MiFID, UCITS and
AIFMD. The nature of these arrangements and the ability for UK firms to continue this business
would be impacted by a change in the relationship between the UK and the EU. A sample of UK
asset managers the FCA recently polled showed that on average one third of their most recent
year's revenue came from such business.
The second, linked example of a significant risk also relates to a sudden loss of passporting
rights, and the implication for cross-border contracts. In the area of insurance products, for
example, some providers currently use passportlng provisions to service their contracts - that
is to say, to process claims. After the UK's withdrawal from the EU, it could become more
difficult for providers to service contracts entered into before withdrawal in the absence of the
EU passport. This is an issue for EU providers to UK consumers and depending on whether and
how those services are regulated in the particular EU State, this could also be an issue for UK
providers to EU consumers. For some types of insurance product the length of the contracts
can be significant, for example investment-based life insurance. Without suitable transitional
provisions, there may be considerable uncertainty created for firms and consumers as to what
the loss of passporting means in practice. We cannot rule out related risks at this stage so my
teams are continuing work to map and consider potential mitigations to these risks.
The third example of such a scenario relates to the operational ability of the regulators to
perform their duties. In my letter of 28 October 2016, I highlighted five principles which, we
believe, should underpin an optimal outcome for financial services in terms of any future
regulatory framework. The third of those principles is cooperation between regulatory
authorities. The current single market directives and other EU measures as well as FSMA5
provide legal obligations for EU national regulators to cooperate and exchange information for
regulatory purposes. These provisions enable a broad range of supervisory cooperation
activities and also help to underpin passporting, whereby EU Member States agree for firms
authorised in other Member States to have access to their domestic markets on the basis that
NCAs are obliged, amongst other things, to share important firm-specific regulatory
information without the need for additional agreements on exchanging and handling
confidential information.
5
E.g. section 354A FSMA requires that the FCA must take such steps as it considers appropriate to co-operate with
other persons who have functions similar to those ofthe FCA.
In such scenarios the FCA may, then, face operational risks in terms of the availability of
important supervisory information on firms doing business in the UK. The information could,
for example, relate to instances of cross-border market abuse - a real threat to our objectives
- where the timely exchange of information is critical to resolve issues. As this information
exchange is mutual, other EU regulators may also face risks around an information gap.
More generally speaking, and linked to the above point on cooperation and information
exchange, any lack of certainty with regard to the regulatory framework may affect the ability
of the FCA, and perhaps other regulators, to take enforcement action as a means of both
addressing and deterring misconduct. Cooperation between regulators relies upon a clear
framework which sets expectations as to what is required of whom, when, and to what end.
Without that clarity it may become difficult to properly discharge our regulatory functions.
Mitigation of 'cliff-edge' risks through transitional arrangements
None of the above risks are beyond mitigation, but the types of solutions required may be
complex. Most of the options above cannot, generally, be achieved by the FCA acting alone but
require action by the Government and, in some cases, reciprocal cooperation from other
governments and European national regulators. Considering these risks in the round, however,
and aiming to avoid - to the extent possible - a 'cliff-edge' scenario, what follow are some
initial thoughts on broad objectives for any transitional arrangements. The primary motivation
is to ensure continuity in the delivery of the FCA's statutory objectives of promoting
competition in the interests of consumers, protecting and enhancing market integrity, and
protecting consumers across all relevant financial markets.
• First, transitional arrangements should offer legal certainty to firms and consumers, and
adequate time to prepare for implementation. Market participants need to understand
their rights and obligations and have appropriate time to prepare for any changes from
the current framework.
• Second, the FCA itself will need to retain an effective and clear rule book following EU
withdrawal. As such, arrangements should be underpinned by a degree of regulatory
continuity.
• Third, arrangements should be attuned to and based upon a clear understanding of
potential risks to our objectives arising post-withdrawal, and offer mitigation against
them. Some examples of the sorts of risks we currently foresee are set out above.
• Fourth, transitional arrangements should allow for continued and effective working
relationships between UK authorities and European bodies, including the EU institutions,
the European Supervisory Authorities (ESAs), and other European national regulators.
Clearly, sufficient time for adoption of any transitional arrangements will be important for both
public authorities and firms. Indeed we recognise that risks related to EU withdrawal are not
unique to the financial sector; in some cases, 'horizontal' solutions may be required, such as in
relation to data protection. The FCA, of course, continues to work closely with other UK
regulators and with the Government to consider risks arising around EU withdrawal and
solutions or mitigating strategies.
I hope this will assist the Committee in its work, and we will of course be happy to follow up on
any points where that would be useful. In view of the substantial content of the letter which is
not contained in any other FCA publication, I am copying it to the Chancellor of the Exchequer,
the Governor of the Bank of England, the Secretary of State for Exiting the European Union
and the Cabinet Secretary.
Andrew Bailey
Chief Executive